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Home>Research & Insights>Fund Times>Scanning the Globe for Income

Scanning the Globe for Income

Silver-rated American Funds Capital Income Builder delivers an above-average and rising income stream without neglecting total return.

Morningstar, 07/02/2017

The following is our latest Fund Analyst Report for American Funds Capital Income Builder CAIBX

Looking across asset classes and throughout the globe, American Funds Capital Income Builder has consistently met its aim of delivering an above-average and rising income stream, while not neglecting total return. Because it's done this without taking undue risk, the fund earns a Morningstar Analyst Rating of Silver.

The fund is poised to become more conservative. Its equity stake has been at the high end of the fund’s typical 60%-80% range since late 2013, but principal investment officer James Lovelace hopes to reduce the fund’s volatility by shifting assets into the bond portfolio until the equity stake approaches its neutral 70% weighting. The fund’s equity stake stood at 77.2% in May 2017, which ranked in the world-allocation Morningstar Category’s top quintile.

Lovelace is taking advantage of two management changes on the equity side to channel assets into fixed income. Timothy Armour left the fund in March 2017 to focus on other firm duties and Darcy Kopcho will retire in October 2017 and Steven Watson, a contrarian investor who likes to exploit the market’s overreactions, will replace her. He oversees Gold-rated American Funds International Growth and Income IGAAXand has 30 years of industry experience.

The bond portfolio is likely to grow beyond its current 19.8% weighting, but it should keep its relatively muted risk profile. Although the fund’s three fixed-income managers dabble in high-yield bonds, they stick largely to Treasuries, corporates, and mortgage-backed securities. They do take some interest-rate risk. In March 2017, the fund’s 5.1-year duration was higher than the 4.6-year category median.

The combination of a relatively long duration and a hefty slug of high-yielding stocks in telecom and utilities can cause the fund to lag when interest rates surge, as it did in 2016’s second half. Over the long haul, though, the fund has done well. Through May 2017, its 7% annualized gain during the past 15 years edged a 70%-30% weighting of the MSCI All-Country World and Bloomberg Barclays U.S. Aggregate Bond indexes. The fund is a worthy option.

Process Pillar: Positive | Alec Lucas, Ph.D. 06/27/2017
The fund aims to be an endowment for individuals by investing in a mixture of stocks and bonds that will produce an above-average and rising income stream. Total return is not the primary aim here, but management keeps it in mind. The equity managers try to avoid stocks whose dividends could be cut and the fixed-income managers, since adopting a mix of specialist and generalist roles in 2012, have shown prudence regarding high-yield bonds. The fund's robust, risk-aware approach merits a Positive Process Pillar rating.

With the fixed-income portfolio serving as ballast, the equity side drives results. While a strategy focused on dividend payers--rather than on yield, per se--may lead to a relatively sturdy portfolio, striving for income often leads to big stakes in the more interest-rate-sensitive sectors of utilities and telecom. Here, the portfolio does tend to overweight these sectors, but the managers also look for dividend growth elsewhere, like tech and health care.

American's multimanager system allows the managers to take their own approaches, but each must meet the fund's pre-expenses yield hurdle, which was about 3.5% in mid-2017. To reduce the temptation to stretch for yield, the team temporarily reduces the yield target when one of its stocks pays a special dividend. After Vodafone's big payout in early 2014, management cut the yield target for the rest of that year.

The fund has a neutral weighting in equities of 70% and typical range of 60%-80%. In contrast to its early 2009 weighting of 60%, the fund’s equity stake has hovered around the upper end of that range since late 2013. As of March 2017, the fund's 80% equity exposure ranked in the world-allocation category's top quintile. This hefty equity stake tilted a bit more toward non-U.S. stocks, which tend to have higher yields. U.S. stocks stood at 39.8%, versus 23.0% in April 2009.

To meet the fund's pre-expense yield target, the equity managers invest heavily in high-yielding sectors like telecom and utilities. At 16.9% of assets in March 2017, the fund’s combined stake was more than all but a few rivals' and higher than the MSCI All-Country World High Dividend Yield Index's 12.5%. That could make the fund more rate-sensitive than most.

The potential risk created by the portfolio's above-average equity weighting is offset somewhat by its conservative bond portfolio. Credit risk is mild, with few bonds below investment-grade. This portfolio is largely split between Treasuries, corporates, and mortgage-backed securities, but it's not very global. The fund has just 1.7% of assets in foreign bonds, well below the 9.7% category median. Interest-rate risk in the bond portfolio is a bit higher than most peers’. The fund has a 5.1-year duration versus 4.6 for the category median.

Performance Pillar: Positive | Alec Lucas, Ph.D. 06/27/2017  
The fund has consistently balanced meeting its income mandate without sacrificing total return, earning it a Positive Performance Pillar rating. Conceived as an endowment for individuals, the fund aims to deliver an above-average and rising income stream. While the fund’s 3.3% one-year yield, as of May 2017, ranked in the world-allocation category’s top quintile, management has had trouble increasing the fund’s quarterly dividend in recent years. It has remained at $0.50 per share since June 2014, though special dividends have added to the fund’s payout.

Management’s restraint in not chasing yield has helped the fund to deliver competitive, long-term total return. Through May 2017, the fund’s 7% annualized gain during the past 15 years beat its customized benchmark (weighted 70% in the MSCI All-Country World Index and 30% in the Bloomberg Barclays U.S. Aggregate Bond Index) by 58 basis points while landing in the world-allocation category’s top third.

The fund built this record by preserving capital in turbulent conditions, including the 2007-09 credit crisis bear market and the 2015-16 correction. The fund, though, hasn’t always kept pace in rallies. It finished in the category’s bottom third in 2009, for example. Early in that year, the fund’s 60% equity stake was at the low end of its typical range, which held the fund back during the sharp equity rebound that began in March.

People Pillar: Positive | Alec Lucas, Ph.D. 06/27/2017 
American Funds' multimanager system helps to handle this fund's $100 billion asset base, the world-allocation category's biggest. The fund’s Positive People Pillar rating reflects its systemic strengths as well as the managers’ experience, ability, and aligned interests.

In 2014, Capital Group, the parent of American Funds, began splitting the fund's equity assets between equity subsidiaries Capital Research Global Investors and Capital International Investors. James Lovelace heads up the whole fund and CRGI's team, composed of Joyce Gordon, David Riley, and Winnie Kwan, Bradley Vogt, L. Alfonso Barroso, and Grant Cambridge. Timothy Armour, who had been a CRGI manager since 2006, left in March 2016 to focus on other duties. Change is also coming to CII’s team, composed of Darcy Kopcho, Phlip Winston, and most recently firm veteran Steven Watson. Kopcho, who has led the team since 2014, plans to retire in October 2017; Watson will replace her. Based in the United States, England, and Asia, each manager runs a separate sleeve of the portfolio in line with his or her style. The least experienced manager has been in the industry for 17 years. The CRGI, CII, and CFII teams each draw on deep analyst benches, with each analyst group also responsible for its own slice of the portfolio.

Every manager invests at least $100,000 in the fund, with eight investing more than $1 million each.

Parent Pillar: Positive | Alec Lucas, Ph.D. 03/01/2017  
With roots tracing to 1931, Capital Group has long been a standard-bearer in asset management. Widely known in the United States for its American Funds open-end lineup, the active manager boasts some of the industry’s more reliable equity and allocation offerings. The firm’s multimanager system is key to its success. Dividing each fund into independently run sleeves lets managers invest in line with their styles, enhancing diversification and reducing volatility of the overall portfolio. The funds’ analyst-led research portfolios help develop the next generation and recruit top talent with the promise of running money from the start. The result is an investment culture marked by lengthy tenures, strong manager co-investment, and competitive long-term records.

Capital Group has improved its fixed-income approach through greater coordination and the addition of veteran managers, but the firm still must show it can achieve the kind of excellence in that asset class that it has with equities. Capacity monitoring, a perennial issue given the funds’ massive asset bases, could become a more pressing concern if the firm’s efforts to grow its business in Europe and Asia succeed or if U.S. fund flows shift back to active management. In the meantime, investors benefit from Capital Group’s modest fees, consistent results, and sound stewardship. The firm earns a Positive Parent rating.

Price Pillar: Positive | Alec Lucas, Ph.D. 06/27/2017
Modest fees earn the fund a Positive Price Pillar rating. Even if the A shares’ fees have ticked up 1 basis point since 2015, their current 0.60% expense ratio, which applies to about two thirds of the fund’s assets, is 64 basis points below the world-allocation, front-load peer median. That ranks in the cheapest percentile of those peers and is also competitive with the category's best-priced no-load options. Plus, all 16 of the fund's remaining classes sport low expense ratios versus similarly distributed rivals. Investors also benefited from reasonable trading costs in fiscal 2016, as brokerage fees of 0.03% of average net assets fell below the 0.05% category median.


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